SPIEF 2016
Igor Sechin’s Keynote Speech at the Summit of Energy Companies
“World oil market at crossroads: uncertainty investment reduction or risk management?"
“World oil market at crossroads: uncertainty investment maintenance or risk management?"
Dear colleagues, participants and guests of the Summit,
On behalf of Rosneft, one of the organizers and sponsors of the Forum, I would like to welcome the participants of the Summit and wish successful work to all of us.
Our Summit is different from all other events, including those held within the framework of the Saint Petersburg Forum – today it is attended by genuine leaders of the oil and gas business, that carry out substantial extensive work in the industry and play the key role in supplying energy to the world economy.
In this regard, sharing our opinions about the situation in the world oil market is especially important.
Disclaimer
Please note that my liability is limited due to deliberative nature of this presentation.
I.
Developments over the year since the previous Summit and
short-term prospects
Oil market volatility and price dynamics
The current situation at oil market is rather more complex and puzzle-like than what we've seen in the period of balanced market. It can be said that market tools
regulating industry functioning have been deformed. The reason for it lies in those notorious sanctions, as well as in reliance on short-term financial market instruments and in manipulation with market institutions at the expense of damage for long-term relations between consumers and hydrocarbon producers as well as for fundamental development factors. Different players are testing the industry and market mechanisms, looking for an opportunity to secure their interests, often to the detriment of the fundamentals of its development.
Even statistics is no longer a reliable benchmark for analysis, since reference points for making both strategic and investment decisions are disappearing.
The market is experiencing unprecedentedly high volatility. Today, the prices have almost reached the level of the year ago, although this January-February, they plummeted down to USD 27/bbl, and a number of large investment banks were testing the levels of USD 20 and below, predicting severe downturns in the global economy, including a “hard landing” for the Chinese economy and stagnation of the economy of the USA.
Analytical agencies do not contribute to forming rational expectations of the market players. On the whole, this is not surprising – the International Energy Agency represents consumers’ interests who were happy with low prices; the American Energy Information Administration of the US Department of Energy published its forecasts without linking them to price levels at all; the position of OPEC’s Secretariat is at odds with comments of its member countries' representatives. Obviously, the issue of adequate information and balanced, substantiated market analysis has become one of the most urgent ones.
In the oil industry, price volatility is projected on a long-term investment cycle of capital expenditures, and the ability of oil companies to meet the demand of the global economy. Thus, the decline in oil prices and volatility have already resulted in the loss of approximately USD 350 billion in investments, which will definitely have its effect in the mid-term. If previously the industry was based on implementation of long investment cycle objectives, now the balance is definitely
upset.
Prospects for the market imbalance decrease in the second half of 2016 Presently, the oil market has started momentum towards achieving the balance in the mid-term. Our expectations in this regard are, for the most part, associated with the year 2017, rather than with the second half of this year. Of course, there is a number of uncertainty factors, primarily, pertaining to the behavior of certain producers, who have actually assumed the role of regulators in the oil market, as well as in the financial sector. At present, a certain positive trend has emerged, but, despite the visible search for balance, risk factors are so numerous that we may lose the equilibrium at any time.
Today, as we move away from the acutest phase of this severe crisis, we can pay more attention to analysis and discussion of underlying factors decisive for the industry development, and it is necessary, in some sense, “get back to basics” by discussing the relevance of the long-term investment cycle for the consumption and the relation between them.
II.
Demand factor and anticipated price behavior
First of all, demand continues its sustainable growth in emerging economies. We all know relevant GDP growth statistics for such rapidly growing economies as China – 6.5% per annum, India – more than 7%, Indonesia – 5%, Vietnam - 7%.
Therefore, in general, we believe that what we hear frequently about threats to development of the global economy and of economies driving the energy demand growth is grossly exaggerated. Even in OECD counties the decline in demand reversed with the growth reaching 1.1% in 2015. At that, along with this potential, the role of alternative energies is presented in a distorted fashion. Not only is it the matter of construction of expensive infrastructure, it also entails loss of budget revenues in the countries that implement programs aimed at developing this sector.
Energy agencies expect consistent recovery of oil prices
mid-term development fundamentals as sustainable demand growth, including new growing markets of emerging economies, and decline of investment activity in the sector, within the forthcoming 4-5 years should result in a dramatic change of the market and its growth after stabilization.
In the medium-term perspective, a certain shortage of new oil supply will appear. It will hardly be a matter of physical deficit, rather, a growing tension in the balance of demand and supply. If the financial market feels it in advance and reflects in prices, we will be able to avoid a new turbulence and to resume the investment process via ensuring an adequate diversification of liquids supply sources.
At least, today energy agencies are unanimous about their confidence with regard to the growth and consistent recovery of oil prices (in real terms). Thus, a few days ago, I discussed these matters with one of the most distinguished global energy expert and analyst Edward Morse, who, in one time, had been the first to predict the shale revolution in the USA. Today the Citi Group analytical service headed by him gives quite optimistic estimates regarding oil prices in the nearest years – more than USD50 this year, about USD60 in 2017, and USD64 in 2018. At the same time, he confirmed that even these price levels fail to cover the full cycle costs for many projects that the industry needs, and, therefore, investments into such projects involve high risks. There are also alternative opinions, for example, many financial agencies are talking about a potential oil price decline - however, in my opinion, and such estimate may be attributed to the attempts to solve the task of creating financial reserves. Everybody pursues own interests. It is essential, though, that industry trend expectations should be articulated by industry-related agencies, thus helping ensure the necessary coordination and unbiased balance of interests.
Separately, I would like to note, that this unprecedented price volatility that we've witnessed, has tested the very basics of the industry. Events of last several years have shown that in fact the paradigm of oil market had changed: for a long time it has been a common belief that OPEC cartel of producers is regulating the oil
market; then, owing to groundbreaking technologies, a new regulator appeared which is the shale oil production in the USA. However, in our view, the new reality lies in the fact that market developments are increasingly determined by a number of factors that include availability and quality of resources, impressive progress in development and application of cutting-edge technologies of the physical market, plus development of financial instruments and financial technologies, regulators’ activities. A special role belongs to regulators.
Resource potential of major oil producing countries
Objective differences in geology and resource base affect the role of certain countries in the world market. I would draw your attention to such countries with a unique resource potential as Venezuela, where our company is actively operating, and Iran, which has been building up its production since the sanctions were lifted. Of course, realization of this potential is currently complicated by a number of factors – infrastructural constraints, the amount of the requisite capital, political factors.
The result of the current crisis, as I see it, is re-estimation of the role, which three main oil producing countries are playing now and will play. They possess not only geological resource potential, but also a wide range of factors needed to influence markets. So the main players are being crystallized. These countries are Saudi Arabia, the USA and Russia. Each of them finds a way to meet these challenges, basing on its resource and technological possibilities, market structure and peculiarities of political and economical decision-making.
III.
USA
Let us first look at the USA – the country where oil industry has become the driver both for the oil market changes that we see today, and the current phase of the technological breakthrough in the industry.
The USA oil industry is one of the oldest in the world, and its onshore conventional resources are mostly depleted. Nevertheless, the USA stands apart due to the size of its domestic consumption market, which consumes more than 800
million tons per year, therefore, in many respects, the domestic market “absorbs” the fluctuations in the production level.
Nonetheless, future production trends will largely depend on the progress in development of shale resources and access to the offshore areas and federal lands – the issue, which is under discussion at the political level.
Anyway, because of the quality of the USA oil resource base, its full utilization will require quite high prices, despite the technological achievements.
Forecasts for US production till 2025 vary significantly
The prospects of the US shale production depend on intensive development of technologies, cost reductions over the entire production chain, and, apparently, the evolving price levels will result in stabilization and even recovery of the shale production. However, contrary to expectations of the many, this growth will not be explosive, since there is no longer any euphoria about unlimited financing of this sector, and a better understanding of risks will lead to a more balanced financial policy.
US shale industry generates losses and debts
Importantly, the US shale industry is commencing to “clear up the debris" resulting from the tight situation in a lot of companies that failed to adapt to the market downturn, are heavily indebted and often operating at a loss (as of the end of 2015, the long-term debt of the companies in the sector exceeded USD350 billion). The spread of efficiency parameters and performance indicators across the industry is extremely wide – as of today, 23% of the most productive wells yield about 70% of shale production, while the rest 77% of wells or a significant part of them generate losses.
Unfortunately, it could be ascertained that at least some of the American industry has found itself in the existing situation because of application of “spot”, financial approaches to the real sector. We believe that such approach is unsustainable – the volatility in the financial sector is too high, and long-term
investment decisions cannot be made on the basis of daily dynamics of price quotations.
US production forecasts till 2040 vary greatly
The long-term outlook for the US production deserves our close attention, in particular, because shale production in the USA may prove to be a more durable factor that it was thought before.
USA elections as a vivid example of political uncertainty
Today USA’s energy sector has found itself at the crossroads in view of major differences in its development prospects which feature in the programs of Presidential candidates – Senator Hillary Clinton and the famous businessman Donald Trump.
In fact:
– The Republicans already today are proposing measures aimed at development of domestic oil, gas and coal production and exports, while Hillary Clinton suggests enhancing support to renewable energies;
– Trump proposes lifting the ban introduced by President B. Obama on exploration and production of hydrocarbons on federal lands, while the Democratic candidate Clinton proposes leaving the same in place;
– Trump’s program contemplates development of market competition among different energy products, including renewable ones, while Clinton’s program implies massive multi-billion subsidizing, including budgetary subsidies, of such sources as solar energy, with raising its generating capacities to 500 GW;
– Trump talks about doing away with domination of the climatic and environmental agenda, up to and including potential withdrawal of the USA from the Paris Climate Agreement, whereas Clinton gives priority to such ambitious goals as reduction of greenhouse emissions by 80% by the year 2050.
The list of essential differences between the two programs can be continued. Considering the role played by the American economy, such uncertainties about the development of the US oil and gas industry (technological, political, and
economic) increase the risks for the global economy.
IV.
Dramatic shifts in Saudi Arabia
Saudi Arabia – changes in the new environment
Like in the USA, where the crisis has necessitated structural reorganization of the shale industry, in Saudi Arabia it highlighted the need for change in the oil and gas industry and economy as a whole. Unlike the USA, Saudi Arabia has no sizable domestic consumption market, therefore, the success of the Saudi oil and gas industry will depend, among other things, on the Saudis’ ability to enter new consumption markets, to create integral partnerships. This ability has to be tested yet, some questions still remain.
I would put it more definitely – having caused the shocks to the world market, the American market could afford the risks only with Saudi Arabia standing behind its back, with its richest conventional oil resource base, which, seemingly, could gain from some new approaches and technologies of the American market. But, as a result, this country did not avoid the shocks either.
In terms of production, Saudi Arabia attempted at coming up with “its own response” to the shale revolution, which we have observed in action for the recent two years. This “response” has proved to be quite painful for Saudi Arabia as well: the dramatic fall of oil revenues and budget deficit of USD100 billion in 2015. The Kingdom has already taken serious steps aimed at changing the taxation system and pricing policy, but in 2016 the budget deficit will exceed USD85 billion anyway. Recently (I mean Vision 2030 initiative) unprecedented reforms have been declared both inside the industry, including partial privatization of Saudi Aramco, and tax reforms of the oil industry related thereto, which are aimed at achieving market capitalization of the company, and in the economy in general, with the purpose of doing away with the “oil dependency” already in the near-term perspective.
As for privatization of Saudi Aramco, we believe that this process will help substantially improve the transparency of the national oil industry, including publicly
available data about oil reserves, which have not been updated for three decades already (over this period, information about Saudi Arabia’s reserves has not changed at all), the economic figures of this country’s major oil resources development. Furthermore, material changes in the technological and financial infrastructure of the country’s oil and gas sector will be required.
As for “shifting away from oil dependency” as the goal of the declared in the plan Vision 2030, we know from our experience how complicated this path is, even considering such Russia’s advantages as highly qualified research talent, advanced positions in a number of spheres of high technology machine building, favorable conditions for development of food and processing facilities. We will be watching Saudi Arabia’s moving along the chosen path with interest.
V.
Trends and fundamental changes in energy sector
Before discussing how Russia responds to these challenges, I would also like to comment on “cross-cutting trends” affecting the whole industry.
Today, a “new technological format” of petroleum industry is being formed, including entry of technologies of fast processing of large arrays of geological data in the industry, which, given visualization and analysis technologies, allows us to speak about a new round in development of the industry’s abilities to use the resource potential.
Considering new prices and technologies development, we see how the role of servicing changes and how requirements thereto increase. The services should be at the forefront of mastering new technologies and suggest the most efficient solutions to operators. Competition in this sphere grows. In our view, cusses will attend only those service companies that take the lead in innovations.
Forecasts show that transportation and Petrochemistry will continue dominating in liquids consumption
In future, development of our industry will be more determined by expansion of transportation sector and increased demand for petrochemical products, in
emerging economies first of all.
According to forecasts, the gas industry will be growing faster than the oil industry. We are actively developing this business and are interested in its growth. Here the drivers are, of course, increased importance of gas for the power industry – a fundamental yet a low-margin sector, and growth of production and use of “gas liquids” in Petrochemistry.
It is distinctive for the gas industry to have expanding competition at main export markets and to conduct policy of gas "sources and supply routes diversification. Entry of LNG from the USA is among it. In the super-low price environment, we face, and have not overcome yet, hazards of “global market decay” and impossibility to implement major infrastructural projects. We observe marginality reduction in the industry amid evolving medium-price environment. We see the necessity of efficient "Russian gas answer" - first of all, meaning providing equal terms at external markets.
Other energy sectors also keep developing. The nuclear energy sector is an important alternative and destination for diversification in power generation. It's a high-tech industry, and in its development we see a transit to technological solutions of civil application of atomic technologies. The maturity stage, which atomic energy sector has entered, makes it very important to obtain experience of “full cycle costs”, which include decommissioning of facilities with expired service life, and further accounting of relevant costs related to implementation of new facilities. It is important to find the right place for nuclear sector in regional energy balances so that to avoid an additional burden for the consumers from lengthy implementation and high CAPEX.
Extensive discussions are also held on renewable energy, and here we find it critical to achieve progress in creation of such important components of renewable energy development as invention of powerful and cheap means for electric energy accumulation and storage, development of fuel stations network infrastructure, and a number of others including the above-mentioned disappearing budget revenues.
I would like to draw your attention specifically to information ambiguity in the energy sector and necessity to cooperate and communicate for all of its members, since development of efficient regulation for global and regional markets falters. I hope that development of interaction, at this Summit of Energy Companies as well, will contribute to filling and in some areas fill this gap.
VI.
Russian petroleum industry, its strengths, development
opportunities, and risks
Russia is a stable player in international oil trading
As you know, Russia is one of the countries with the largest volumes of oil production and supply to the global market.
As we have seen, major oil producers significantly differ in their resource potential, infrastructure availability, technologies and competencies, as well as in structure of their regional supply and demand balance. As for supplies to the global market, Russia has important advantages vs. other countries: well-developed export infrastructure including pipelines, fairly low debt burden, marketing system tested by decades and successfully supplemented by long-term contracts, integration in growing eastern and stable western markets. This model provides consistency, efficiency and stability of Russian oil exports.
Another matter of importance is the balance of supply and demand in Russia - given the high level of domestic demand; existing capacities allow exports diversified in accordance with directions and products. This is what makes the place of Russia in the global petroleum industry very distinct.
Within last two years, oil industry of Russia has been affected by the global crisis as well. However, this negative impact was rather limited, especially if you recall the reaction of many other players. This surprised many observers and analysts, who were not prepared for such development – in the midst of upheaval Russian oil industry seemed to be a terra incognita to many observers and analysts, but "as a result, taking into account its resource base, the results achieved, market
institutions, presence of quality market channels, it is becoming a terra fertilis, a fertile land.
What lies behind of this phenomenon?
Russia has a huge resource potential and Russian oil projects are cost-efficient even if the oil prices are low.
First, I would mention the scale and high quality of Russian hydrocarbons resources. In addition, well-developed supply infrastructure, long traditions of industry workers training, and good engineering school. Based on these pre-conditions, Russian oil companies ensure one of the lowest in the world levels of “per unit” costs of resources development. For Rosneft today it is 2.1 USD/bbl.
There are new big promising projects in Russia, allowing us to maintain the oil output and the investment level while the majority of foreign public and national companies are cutting their capital costs and are forced to re-evaluate their project portfolios due to the lack of attractive investment projects in the evolving price environment.
Russian oil production so far has been developing under an upside case but it is not the limit
Growth of oil production in Russia was ensured through introduction of new projects that were mostly prepared with the governmental support before the crisis. During the economic downturn leading Russian oil companies optimize expenditures and do not suspend implementation of these projects. In accordance with the base case of the General Plan of Oil Industry Development till 2035, which is under approval now, oil production in Russia will remain stable. However, in order to achieve this target, a stimulating taxation system is required. This work should be accelerated before discussions of pilot projects result in the start of production decline.
A key parameter determining oil production in Russia is fiscal environment, not oil prices. According to the official independent evaluation by
Ernst&Young, in 2015, when the average oil price was $51 per barrel, Rosneft paid taxes of almost $25 per barrel of oil produced. It is much more (in some cases 4 to 5 times more) than foreign companies did. It should be noted that these tax payments are fixed as part of the so-called ‘big tax maneuver’ that was developed and implemented considering the oil price above $100 per barrel. Obviously, it is important to readjust it in accordance with the new reality of medium-term oil prices. Even more so that literally yesterday we saw the Ministry of Finance’s evaluations of risks of further oil prices decline.
In my opinion, the point of taxation is quite simple: oil price is $50 per barrel; production cost is $2 per barrel. Even if the full cost is a little higher than $10 per barrel – accounting for transportation and other costs. Target fiscal system must provide for the stimulus to upstream investment until production cost of additional barrel is less than market price for a barrel. If we talk about downstream, cross-subsidization within vertically integrated systems cannot be treated as economically appropriate method of business operations - all dimensions of company's activities should be economically justified. That is why taxation of downstream should also be rational and stimulate investment.
Two most important sources of oil production: Brownfield and non-conventional resources
I see significant untapped capacity of the fields in West Siberia, yet I would also like to mention that Russian non-conventional resources are the largest in the world and by 1/3 exceed similar resources of the USA (according to Goldman Sachs). They include a whole range of geological formations, in particular Tyumen, Bazhenov, Domanik, Khadum suites, etc. In order to develop each of them efficiently, certain technology modifications are required. In the last years, Russian companies made serious progress in those areas. We actively apply multistage hydraulic fracturing, we drill extended directional wells. You also know about our joint experience with Exxon when we drilled directional wells with a record step-out of more than 12 km.
For such capital-intensive industries as oil and gas production, it is important to account for multiplier effects showing how the investment and operational expenditures occurring here spread out through the system of inter-industry relations, and increase production and revenues, hence the growth rates of the economy at large. Judging by the investment projects of our company, we know that additional growth of production in economy during the lifetime of the projects sometimes exceeds the initial costs by tens of times.
We believe that in the nearest decade maximum potential is related to efficient use of our unique resource base of conventional oil, including areas of West Siberia with well developed infrastructure. Only Rosneft’s proved reserves amount to 29.8 billion barrels, which is sufficient for us to develop for another 20 years even without expanding this base.
In Russian oil industry, which has been operating for many decades, there are a lot of Brownfield assets. Certain stimuli for oil production increase were introduced, and in the last years production went up in these fields. Yet, with due tax stimulation, oil recovery ratios currently slightly exceeding 20% may well be increased to over 40-50%, which the best global projects have been showing in the last years.
Such development will be accompanied by the most efficient use of the existing infrastructure and in the mid-term will maintain the environment of mutually beneficial cooperation of state and business – development of the most efficient resources and, hence, sufficient budget payments.
Of course, it all speaks of the increasing role of efficient regulation of our industry.
When planning the rate of changes in the Russian oil industry, one should account for the fact that under the severely complicated operational conditions such countries as Saudi Arabia, Iran, and Mexico already have taken actions for improvement of investment attractiveness of the industry and its projects. This is not to mention the USA, where without significant governmental support the shale oil industry would not even come to life considering the high prices at the period of its
establishing.
VII.
Rosneft development
Let me make some final comments on behalf of the Company. Today, Rosneft is the largest publicly traded oil company in the world, taking the lead on the global level by a number of economic and resource indicators.
We are aimed at development of the new projects. Our role is to combine unique geology of Russia with capital and the leading expertise of the partners.
In September 2014, in the Kara Sea, Rosneft and Exxon's JV drilled the northernmost oil well in the world – Universitetskaya-1 – and discovered the Pobeda field. This is the largest field discovered in 2014 in the world. The field reserves amount to 130 Mt of oil and 396 bcm of non-associated gas. As a result, we successfully created a new strategic area for shelf development.
Pobeda is the northernmost project in the global oil and gas industry, unique both from the viewpoint of technologies and interaction with partners. Nevertheless, it is only the beginning. Successful discovery of the new field by drilling of the very first well confirmed justification of estimations of our geologists and our partners’ specialists – in essence, we speak about a gem of the global oil and gas industry.
This discovery allowed confirming continuation of the largest West-Siberian petroleum-bearing province to the Kara Sea shelf. The experts say the scope of resources here is larger than in the Gulf of Mexico, the Brazilian shelf, the Arctic shelf of Alaska and Canada, and will be comparable to the whole of the existing resource base of Saudi Arabia. More than 30 structures are found on three East-Prinovozemelskiy blocks of the Kara Sea only. DeGolyer & MacNaughton estimates the resource base of these blocks at 87 billion barrels or ca. 12 billion toe.
We are looking at the years of intensive work, billions of investments, application of the most advanced and innovative technologies, but the biggest thing is already in place – there are no doubts that this is the richest region full of high quality oil! Of course, the projects of this scale are advisable to develop in cooperation, and
we are fully prepared for that.
Upon the whole, I would like to note that we are ready to open our resource base; we attract foreign investors both to share risks and to strengthen and develop technological competencies of the industry.
In addition, I would like to mention the transactions for investors entering the Vankor Project. In the end of May 2016, we closed the deal with ONGC for purchase of 15% in the Project. This is a marquee transaction for both companies and marks transit to the new level of cooperation in Russian-Indian relations in the energy sector. ONGC will receive a significant share and corresponding rights in one of the largest projects of Rosneft over the past decade.
We relentlessly improve efficiency of our work in all areas and try to turn the Company into one of the leading transnational players, responsible, open and determining the face of the industry in the nearest decades. An important factor of such success will be the efficient dialogue with our dear colleagues and partners present here today.
